Positive momentum pushing mkt to higher levels: ICICI Pru

Excerpts from Midcap Radar on CNBC-TV18 Watch the full show » RELATED NEWS Bond markets rejoice rupee appreciation Liquidity tightening concerns to remain: Ramesh Damani Mkt momentum high; 15,000 in sight Mkts touch new highs; Experts cautious on IT nos Sensex may touch new all-time highs

Nilesh Shah, CIO, ICICI Prudential considers the positive onset of monsoon as one of the drivers for the markets. He also considers the India story being told and retold to investors around the world by various brokerage houses to be another factor affecting the markets.

All the factors put together are bringing in liquidity. So, according to him, the momentum is still positive, which is pushing the market to higher levels.

Excerpts from CNBC-TV18's exclusive interview with Nilesh Shah:

Q: We have broken into new highs. Fundamentally, what do you think has caused this changed in sentiment and do you think it can support higher levels?

A: I think the positive onset of monsoon is one of the drivers. Second is the India story being told and retold to investors during the IPOs - during the conferences around the world by various brokerage houses. All these things put together is bringing in liquidity and economic numbers continued to be good, except for some softening in the auto sales and the two-wheeler sales. So, the momentum is still positive, which is pushing the market to higher levels.

Q: How are you feeling about the twin concerns of inflation and interest rates? Have they genuinely cooled off?

A: On the interest rates side, last time when the US interest rates had gone up, I had said that the Fed was completely discounting any rate cut and if the US treasury has gone up that is not a big deal. Today, we are at a scenario where the global interest rates are probably on its way up; the European Central Bank, the Japanese Central Bank and the Bank of England are likely to raise rates. But that is duly factored into the prices. The US is in hold, which is duly factored into the prices. The Indian interest rates are probably going to remain range bound; there is no significant movement either on the way up or on the way down, which too is  fairly factored into the prices.

Inflation has been coming down, purely on the base effect and also because of the steps taken by the government and the Reserve Bank to control liquidity and bring down the import duties. So, that too, is fairly well-factored into the prices. My feeling is that if the interest rates and inflation remain around the market expectation levels, they will not influence the prices.

Q: What is your call on cement as a commodity and would you buy it now?

A: Well the credit should go to Udayan that he got from the Finance Minister that he was not against a cement price rise. On the serious side, I think the cement consumption is given based on infrastructure spending; and as the growth of the economy transforms from a consumption-led one to an infrastructure or capital-spending one, cement will be an important tool. So, on the demand side, there is not much of an issue, while on the supply side, the capacities are coming; but they are all fragmented in nature and are more back-ended. And not all capacities are coming at the announced time.

So, probably the cement sector does provide an attractive opportunity to invest, notwithstanding the sharp run-up that has happened in the recent times; and especially, the focus should be on midcap cement companies and many of them are available even today, below the replacement cost or around the replacement cost. They are all available between 3-4 times; the midcap cement companies will do better than the large cap cement companies.

Q: Is there merit in looking at the other sectors that have underperformed up until now, like autos or pharmaceuticals or FMCG as well?

A: On the pharmaceutical sector we were overweight and have suffered the pain of underperformance in the market. So I had probably be a little biased in saying that one should look at pharmaceutical companies. However, I still present my side of the argument. One, the pharma companies are not dependent upon monsoon or interest rates or currency moving up and down. Second, though most of these pharma companies are growing at 15% and 20%, they are generating return on equities upwards of 20%. Most of them have very clean balance sheets with very limited debt and limited working capital. So, keeping all those three things in mind, at this level of valuation, we think the pharmaceutical sector should be part of the portfolio. It will give you low beta return, low risk and reasonable return kind of thing. They may not be market outperformers over a longer period of time, but will certainly be outperforming the market in the shorter period based on their superior return on equity. But as I said, we have been overweight on the pharma for long and probably a tired bull is speaking on that.

One phenomena that we are seeing in the FMCG sector is that the margin is getting squeezed, because of the cost pressure and because modern retail or organised retail taking over a little bit of space. Within that context, the urban and rural consumption, are getting two different sides of valuation. At current level of FMCG, except some stocks where one could see aspirational buying coming in, we are not really too bullish on that sector. I think that the sector will now suffer the brunt of rising interest rates and rising EMIs and probably softening consumption; the focus should be more on capital spending or infrastructure spending sectors.

Q: There has been quite a bit of excitement in the run-up to DLF's listing tomorrow. What is your take on the real estate stocks and how do you expect DLF to do tomorrow?

A: My feeling is that DLF has the onerous responsibility of leading the rerating of the real estate sector. They are a giant company; their products and projects are well known. So, there is no worry on the execution capability side or on the management side. The worry is clearly on the valuation side. If DLF adopts principles and practices of a company like Infosys in corporate governance and disclosure and investor servicing, I am sure, it will go a long way in not only getting a good rating for itself, but also changing or showing the way for the entire real estate sector. World over, real estate is a fairly large component of Index and I see an onerous responsibility on DLF to take that charge and make real estate a large component of Indian market capitalisation also.

Q: What is the call on sugar as a sector? That too has been bogged down by a lot of fundamental supply-demand issues. What did you make of the government's recent efforts to try and alleviate some of the pain through increases in buffer stock? Do you think those will work?

A: In sugar, there are two opposite circles working. On the global side, the excess supply of sugar is around 7-9 million tonne for this season and the estimates for next season are 11-13 million tonne. Of that, the bulk is actually coming from excess sugar supply in India. If we see globally, most of the other countries, including Thailand and Brazil, by virtue of a shift of ethanol into the petroleum side or the replacement of oil side, is creating some sort of balance supply in sugar. However, on the Indian side, we have hugely excess supply of sugar and now, it is also probably going to create a little bit of problem in terms of the ability of the sugar mills to pay the sugar farmers. So, somewhere the government intervention was necessary to take over a little bit of excess supply and bring the market back to some sort of equilibrium. This 5 million tonne of sugar buffer stock being created by the government will take away almost 40-50% of excess supply in the Indian system. But the excess supply still continues to be there. If in the next season, sugarcane is being grown in the same proportion as this year and the next year's supply also is fairly large, then you won't probably see a drop in sugar prices; but you are certainly not going to see a rapid rise or reasonable rise in sugar prices, which at this point of time makes sugar sector unattractive. Sugar company stocks have bounced back in the last couple of days and probably this will be more attributable to long-term value-based buying rather than momentum buying, which is seeing good days for sugar sector, over the next 6 months to one year period. They are probably taking a little longer term call on the sugar-cycle saying that oil prices are high and there will be replacement of sugar and other food products into ethanol and oil over a period of time, which will remove this equilibrium. Then, sugar prices can move up and it is better to acquire your stocks at this  then wait for 2-3 years for a patient return.

Q: There has been quite a run in the entire midcap universe even though the Index was flat for a while. Are you sensing any change amongst the retail investors between equity schemes and fixed income products? Has there been a shift, back to equity in the past month or so?

A: We haven't seen any noticeable shift in the fixed income to equity kind of thing. However, all our existing funds continue to received their subscription and we haven't launched any NFO since February 2007. This kind of increased retail participation on a regular basis, in ongoing scheme is something, which is welcomed. However, one point that needs to be kept in mind, while evaluating this spectacular performance of select midcap stocks is also the emergence of mom-and-pop private equity, venture capital, hedge fund, no matter by whatever name you want to call them.

Now, there is this huge set of fund managers moving into that space. They are all picking up stories on the entrepreneurs, sectors, or on the companies which they find comfortable, because they are investing in fewer of those stocks in larger quantum. They are getting involved with the company, developing the strategies, developing the investor communication practices and are far more comfortable holding on to that stock, which is why certain midcap stocks with the concepts, stories, with the kind of support for quasi-private equity, hedge, venture capital funds is constantly doing well. So, lot of this midcap performance could be attributed to the emergence of quasi-private equity funds.

Q: What do you expect to see from amongst these three rate sensitves by way of outperformance? Will banking indeed be far ahead of real estate and autos?

A: It is a fairly tough call. Today the banking system is flushed with liquidity; the overnight call money rates have come down to 0% and 1%. The short term end of the curve has declined by 100-120 basis points. All these things should help expand net interest margins, or NIMs, for the banking system. The slowdown in credit too will help them price the credit reasonably, which again should help them expand NIMs. The third and the most important factor probably is that the asset prices have remained strong. So, there should not be any concerns of non-performing assets in case of little bit of softness in the economy. So, you have Goldie Locks kind of scenario, with NIMs expanding and non-performing assets not climbing. That should be beneficial for the banking sector as a whole and with the kind of capital that is being raised by the banking sector - private and public - this again gives us impetus in terms of better price to book value ratios. So, net-net, my feeling is that the banking sector should be doing well.

The autos are probably going to take time to recover, because the softness has just begun and we have started seeing declines - sharp declines - in two wheelers sales. We have started hearing reports of dealers being choked with commercial vehicle inventory. We have started hearing this softness in the four-wheeler sales. So, auto sector per se, probably still has little bit of downside to go, notwithstanding the bottom fishing, which will continue in one stock here and there.

The real estate again, places the conundrum, because the real estate prices have started coming down little bit all over the country. Now, as we see in Mumbai - especially around my office - the towers are getting completed and they are reaching the stage of completion. We could see some sort of inventory coming into the system. It will be interesting to watch the prices. If along with the inventory supply, the real estate price continues to remain stable, then probably this is the best time to pick up real estate stocks, because they are still available at a discount to their market value or book value of land. However, if we see that with the inventory supply coming in, real estate prices could come down; then, probably one can wait little bit before accumulating real estates stocks.

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